At the end of May, the values of most of The Dividend Hunter recommendations were above the entry prices in effect when the stocks were first recommended. I was feeling pretty good at that time. June and July were not kind to high yield share prices, with typical declines of about 10% over the two month period and more than a few of The Dividend Hunter high yield stocks dropping even further. As I noted in my intro, there is a widely held misconception that a short term change in a company’s share price shows that something good or bad is happening with the company. The truth is that absent any real news about or from the company, share price changes are a function of how stock markets function to fill buy and sell orders.
A stock exchange operates to match buyers and sellers, so that every time an investor wants to buy or unload shares, there is another investor to take the other side of the trade. This is an important concept to grasp: Each stock trade involves someone who doesn’t want or like a stock for whatever reason and a counterparty who thinks the stock is a good investment. The market’s auction system operates to make sure that there is always a counter party whenever someone wants to buy or sell a particular stock.
A share price changes when there is an imbalance of buyers or sellers. If more investors want to buy than there are sellers at the current price, the share price will increase until more existing share owners are willing to sell at the new higher price. However, a higher price can entice more even buyers and share owners can become more reluctant to sell because they see the price going up. These factors can continue to push the share price even higher. Higher share prices bring out greed on both sides, buyers don’t want to miss out on the price run-up and share owners don’t want to sell. As a result, the share price can continue to move higher, fueled only by the fact that the price is moving up.
The same thing happens when prices are falling. Share owners see the price dropping, get scared and want to sell. Potential buyers see a falling price and are reluctant to buy. The share price goes lower to attract buyers, but the lower price scares more share owners into placing sell orders and potential buyers hold out for even lower prices. The result is a share value that can fall much further than logic would indicate. To illustrate how extreme fear selling can affect share prices, I use an example from the last bear market. During the 2008- 2009 stock market crash, I watched Aircastle Limited (NYSE:AYR) fall to under $3.00 per share. At that time, AYR was generating $4.00 per share per year in free cash flow. At that point in the fear cycle, Aircastle was valued at less than the amount of free cash it was generating every year. Within a year of the market bottom, AYR was trading around $12.
A fear-driven selling cycle in an individual stock or a market sector or the overall stock market becomes a completely mechanical response to investors trying to get out of a stock for the sole reason that the share price is falling. Think about this result of the market’s continuous auction system. Lower prices bring out more sellers than buyers and higher prices give more buyers than sellers. The natural result is a greater number of investors will buy when prices are high and greater numbers will sell when share prices fall. The majority of emotion driven investors are pushed by those emotions to buy high and sell low. Not a recipe for investment success.
Your understanding of how the stock market process works should allow you to stick with your investments when prices are falling. It will also make it easier for you to logically, and unemotionally watch market declines and make future share purchases at lower share prices.
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